The Unholy Alliance of Monetary Expansion and Fiscal Austerity: More for those who have, less for those who don’t

Anyone observing the course of macro-economic policy in industrial countries over the past few years cannot help but notice an over-riding pattern: monetary expansion, fiscal austerity. This is an unholly alliance, in which the most regressive form of stimulus tacitly underwrites a fiscal contraction that punishes the least well off for the financial crisis and subsequent economic stagnation. (Skip the next two paragraphs if you already know the basic facts.)

Consider first some well-known facts. In the United States, the Federal Reserve has pushed interest rates about as low as they will go, and says it will keep them at the lower bound until 2013. It has also engaged in two rounds of quantitative easing, first buying in 2008-2009 over $1 trillion worth of MBS (Mortgage Backed Securities) and agency securities, then in 2010 it bought $600 billion worth of Treasury bonds, as well as the less significant Operation Twist. These measures have, in a narrow sense, been somewhat successful, with the Fed making profits on its original asset purchases, recently returning $77 billion to the Fed. The easing of the 2008-2009 credit constraints has acted as a kind of stimulus to the US economy by increasing the money supply, though strong doubts persist as to any further marginal improvements the Fed can make (e.g. Here and here). Meanwhile, while the Fed has pumped like crazy, state spending has come under serious attack. To be sure, there was the initial roughly $800 billion stimulus in late 2008, but this was almost entirely offset by contractions at the state and local level. The contractionary trend continued in 2011 such that government employment was “down by 280,000 over the year. Job losses in 2011 occurred in local government; state government, excluding education; and the U.S. Postal Service.” And then there is the whole super-committee, trillions of dollars in savings issue waiting in the wings.

We find a similar story in Europe. There have been in some cases multiple rounds of austerity in Greece, Portugal, Spain, Italy, Ireland, United Kingdom, France, Germany, and so on, despite record level Eurozone unemployment and economic economic stagnation, verging on recession. Meanwhile, despite initial recalcitrance, the ECB not only has pushed interest rates low, it has begun quietly expanding its balance sheet, offering nearly $500 billion in cheap 3-year loans, and after the recent success of Italian and Spanish bond auctions, has suggested it will loan more money in February. Fiscal austerity, monetary expansion.

Now one perfectly reasonable response to this relationship between central banks expanding the money supply and central governments contracting demand is to say “thank God for the Fed/ECB! At least there is one sane institution left intervening in the economy.” And as a response to those banging the drums of austerity, who believe in ‘expansionary austerity’, or to those who think the Fed is the root of all evil, this is a perfectly reasonable response. Austerity makes things worse, and displaces the costs of the crisis onto the worst off; the Fed, though it is not a progressive institution, is not the root of all evil. However, there is more going on here than that.

For one, in the European case, the tradeoff has been explicit. Draghi held out for as long as he could, on the grounds that Europe had to get its fiscal house in order before the ECB would become more adventurous. Moreover, as Henry Farrell has pointed out, while the raison d’etre of central banks to be insulated from political pressure, what this really means is that they are insulated from the kinds of political pressure felt by elected representatives, i.e. democratic political pressure. They are not from political pressure tout court. Instead, they are influenced by those like them, who speak their language of expertise and money. This makes it much easier for them to propose ‘solutions’ that hurt the majority – who do not so easily understand financial matters, nor tend to produce expert knowledge about it. Which is why it is easy for them to be so nonchalant about fiscal austerity, and why one hears very little about how regressive stimulus through loose monetary policy is relative to fiscal policy.

Just a refresher on that last point because it is relevant. Those best able to take advantage of low interest rates are those with positive net worth, not to mention financial savvy, which is for the most part the wealthy. And it does so without forcing them to invest in any particular way (one of the reasons why it can be of limited use as stimulus – borrowers can just park their money in T-bills, Swiss francs, or some other safe asset, rather than invest in job-creating enterprises). Additionally, it indirectly helps the wealthies by boosting the stock market, and thus those who gain most from increases in stock values (regardless of the underlying employment situation.) Moreover, as Doug Henwood has pointed out, monetary stimulus does the least to disrupt the existing class structure. It increases the ability of private borrowers to spend without actually altering the ability of average workers to earn or increasing their bargaining power with employers. Fiscal policy, on the other hand, especially something like jobs programs, puts a floor under wages, increases demand for labor, and thus changes labor-capital relations. On top of which, it challenges employers’ claims that they should possess exclusive control over investment.

The unholy alliance between monetary expansion and fiscal austerity is more intricate yet. A further response to those who want to present central banks right now as the only sane actors is that their expansionary activity deadens the impact of the insanity. That is to say, even when central bankers argue there should be more fiscal expansion, as Bernanke is reputed to want, their expansionary monetary policy conceals the full damage of the fiscal policy. It gives even greater room for fiscal irrationality. In all, the unholy alliance amounts in practice to a kind of policy combination that serves to redistribute upwards: fewer social services and public benefits for majority, alongside a monetary policy that directly or indirectly benefits the wealthy. And this combination does little to address the underlying sources of the crisis and continued lack of employment/stagnating wages.

Finally, and this is the most difficult part of the unholy alliance to tease out, there is a deep-seated, tacit ideological dimension here. The willingness of central banks to engage in massive pump-priming seems to us to be conditional in certain ways on a certain balance of class forces. The balance is one in which working class demands are weak, expressed not just in more passive unions with lower membership, but in the wider ideological defeat of the idea that public power could be used to meet the basic needs of all and even to socialize investment. Central bankers, once called in to lower the American standard of living by raising interest rates, have been freely keeping interest rates low now that weak labor bargaining power practically eliminates fears about inflation (a reality to which German bankers have yet fully to adjust.) It is harder to imagine an expansionary monetary policy, at least of the magnitude that we have seen, in the midst of a more robust fiscal response by the state to protect the bargaining power and living standards of workers, not to mention in the midst of significant labor militancy. Insofar as the absence of strong political support for expansionary fiscal policy registers the wider political weakness of the Left, the unholy alliance speaks to the ideological hegemony of conservative economic views (despite the hand-wringing of certain Austrians and ‘end-the-Fed’ Randians.) While the credit crunch was supposed to have discredited economic orthodoxy, in fact it seems to have created the conditions for its consolidation. The result: easier money for those who have, less for those who don’t.

Sturm und Draghi

The announcement that the ECB “unleashed a wall of money” to prop up ailing European banks has been greeted with general positive noises, and some confusion. The money is €489 billion in three-year loans, meant to inject liquidity into a tightened banking system, and to allow the banks to, among other things, buy up sovereign debt that the ECB won’t buy directly. The confusion arises from the relationship between the words and actions of Mario Draghi, the recently arrived president of the ECB. Draghi has been at pains to say that the ECB will not act as a lender of last resort, buying up sovereign debt that nobody else wants, without a major EU treaty-change that includes enforced austerity. As he said in an interview with the Financial Times “We have to act within the Treaty. In general, there must be a system where the citizens will go back to trusting each other and where governments are trusted on fiscal discipline and structural reforms.” Yet, as any number of commentators have noted, providing this wall of money seems to be a kind of end-run around the treaty problem. Though it might not work in the long-run, it is taken by the likes of Paul Krugman as the admirable ‘subtlety‘ of eurocrats, finding solutions within the legal arrangements.

There is of course something positive about the head of an unelected, somewhat secretive, yet enormously powerful institution formally stating that he must follow existing law – the EU treaty in this case. Indeed such affirmation of the treaty is especially important given that many have called on Draghi simply to ignore the treaty and backstop the sovereign debt of southern European countries, or argued that it wouldn’t really violate the treaty. But there are deeper, more widespread political problems here, not least with Draghi’s own political game. If, in fact, Draghi and the ECB were merely playing the responsible Big Bank, keeping its head down and following the rules, and leaving the politics to the politicians, then that would be…something. But it is quite evidently not what Draghi has been doing.

The two-timing – saying one thing, and coming up with new, inventive ways of doing the other – illuminate something of a power game that the ECB is playing. Publicly, Draghi is holding back the ECB backstop under conditions – namely, judicially or politically enforceable limits on fiscal policy of European states, inscribed in a new treaty. That is a straight-up political demand, backed by the power that only the ECB possesses: the economic power to bail-out the southern states and European banks. It is a political demand, moreover, made upon already hurting European publics to endure not just a period of contraction, but a major restructuring of the relationship between their states and their economies. The idea behind the rewritten treaty, in other words, is not just to impose the pain of austerity measures, nor even to dismantle the welfare states, but to inscribe the logic of constraint and lowered expectations into the new supranational and by extension national political institutions.

Draghi, of course, is not the only political agent here – Merkel has led the charge for treaty-change with austerity written in. But her actions are unabashedly and professedly political, and understood to be so.  Draghi’s statements and positions are taken to be somehow the words of an expert, nevermind the ‘subtle’ coercions of offering a continental bailout only on strict terms. Draghi’s views are supposed to be the limited advice of an economic expert, and one who in some sense a neutral actor, outside and above politics – like the institution he runs. What makes the political ploy here worse is the power that backs it. As noted, the ECB is the only one with the potential to offer a bailout, or at least commit to printing enough money to buy up debt, which might calm the bond markets and save the banking system. In certain ways, then, Draghi is not just more German than the Germans, but has a power they don’t have.

Of course, the two-timing – such as the wall of money – reflects the fact that the ECB is not all powerful. Or at least, that it is not so flush with power resources that it can wait out this game of financial chicken longer than those unwilling to make the sacrifices Draghi demands. After all, waiting too long makes backstopping a whole lot more expensive, risky and potentially less effective – no doubt one reason Draghi felt compelled to engage in this recent refinancing operation. But it has to be said that Draghi is playing a political game, one that favors certain interests over others, with potentially far-reaching consequences depending on the ultimate political and legal changes.

Of course, as mentioned, the point is not that Draghi is some all powerful financial witch-doctor, who can wave his magic wand – or not – and get the world to do his bidding. In fact, the other striking feature of the debate around ECB actions is the way in which it speaks to the restoration of a certain status quo ex ante. Although the financial crisis of 2008, and its potential sequel in Europe, produced numerous arguments that mainstream economics had been discredited, and that a “new economic paradigm” was needed, what is striking is just how little has changed. Before the crisis, the dominant view was that a period of Great Moderation had been achieved, largely thanks to the machinations of expert central bankers who fiddled with interest rates. One of the background assumptions of this view was that monetary, rather than fiscal, policy was a finer instrument of economic engineering, not least because ‘less political’ and thus less prone to the messy distortions of democratic politics. Central bankers were gods, or at least master governors, to be appreciated and listened to (despite their continued interest in things like wage suppression). Little moves with interest rates were guessed at and awaited; the public divined, parsed, and poured over statements by the likes of Greenspan a bit like Kremlinologists looking for the relevant post-Cold War obtuse institution of power. Everybody knew that their economic fate was largely out of their hands, but thankfully in trusted hands.

Now we are supposedly on the other end of that paradigm, yet caught in the Sturm und Draghi of another bewildering central bank’s enigmatic words and actions. It is hard to accept how it is that so little could change. Or worse yet, how much the old pattern in certain ways has become even more entrenched. The most significant economic decisions are placed in the hands of undemocratic figures, even when this means toppling national governments (Italy, Greece) to replace them with technocrats. And the dominant common sense is in favor of austerity, rather than rational, democratic control of the economy. The dead-weight of ideological conformity and (hopefully changing) public passivity is what stands out most strongly. At the end of the day, the power of a figure like Draghi is a back-handed reflection of the relative absence, or at least weakness, of alternatives. The truth in the conspiracies about bankers manipulating everything is so much that central bankers favor certain interests but dress up their policies as the public interest (which they certainly do). Conspiracies are a distorted registration of the weakness of the Left, a distortion dangerous because it replaces the political weakness of a potential movement with the comforting illusion that power is beyond anyone’s reach in the first place. Draghi and his ilk should be put in their place and own up to the political game that they play. But they won’t do it voluntarily, and it will take another kind of politics to expand rather than shrink the horizon of economic possibility.